Of all the major currencies, the New Zealand dollar experienced the steepest losses against the greenback today. The Reserve Bank is not scheduled to meet for 2.5 more weeks but investors are rushing to square their long NZD/USD positions. By now everyone knows that all signs point to a pause in the central bank’s tightening cycle but there’s a growing chance the RBNZ will lower its forecasts for inflation and interest rates. Since the last monetary policy meeting, we have been watching the decline in dairy prices very closely and the news that Fonterra, the world’s largest dairy exporter and New Zealand’s largest company officially lowered its payout to local producers by almost 20% is a big story with long term ramifications. Although the New Zealand dollar did not respond initially to the report, in the medium term lower payouts will be negative for terms of trade and GDP growth, which could in turn slow tightening by the RBNZ. The following chart illustrates the correlation between the price of whole milk powder and NZD/USD. Since February, dairy prices have fallen 23% and while the NZD/USD also declined, we believe there’s scope for further weakness. Just like the euro, we expect NZD to drift lower ahead of the RBNZ rate decision with a test of 84 cents likely. Aside from the changes made by Fonterra, New Zealand business confidence also dropped by the largest amount in 2 years. The Australian and Canadian dollars trended lower due in part to the decline in Australian leading indicators. Canada’s current account balance is scheduled for release tomorrow along with average hourly earnings and based on the rise in the trade balance, a smaller deficit is expected.

Dollar: 10-Year Yields Drop to 11 Month Low

The top story in the financial market today was the decline in U.S. Treasury yields. Without any specific catalyst ten year rates dropped to is lowest levels in 11 months. As expected this decline drove USD/JPY lower but the sell-off was relatively shallow and the dollar actually appreciated against all other currencies. Considering that U.S. stocks ended the day virtually unchanged, the resilience of the dollar cannot be attributed to risk aversion. Instead, interest rates around the world declined and in many places like the U.K., the decline in 10 year rates was greater than the decline in Treasury yields, shifting the balance in favor of the dollar. At the start of the year, selling U.S. Treasuries was one of the hottest trades and now it has become one of the most frustrating. The prospect of easier monetary policy in Europe kept yields under pressure and unfortunately with many central banks around the world expected to keep stimulus in place for as long as possible, it may be a while before rates start to rise. Tomorrow’s revisions to Q1 GDP, jobless claims and pending home sales reports are not expected to have a significant impact on the dollar although softer readings could keep yields under pressure. As we said in yesterday’s reports, the sell-off in U.S. rates confirms that investors are betting the Fed will be wrong. According to their official forecasts, the main interest rate is expected to reach 1% by the end of 2015, which contrasts with the market’s pricing of only 50bp of tightening by the end of next year. With the central bank gradually drawing its Quantitative Easing program to a close, U.S. yields should be trading at much higher levels but slow growth and low inflation has led many investors to believe that the central bank won’t be raising interest rates anytime soon. This expectation explains why the dollar’s reaction to stronger data has been so benign and why yields refuse to rise.

EUR Drops Below 1.36 on Weak German Data

The euro extended its losses against the U.S. dollar today on the back of weaker German data. Despite a sharp rise in the employment component of PMIs, German unemployment rolls rose by 24k in the month of May after falling 25k the previous month. This was the worst month for job losses since 2009 even though the unemployment rate remained unchanged at 6.7%. According to our colleague Boris Schlossberg, “the news on the labor front suggests that even the mighty German economy is starting to experience some headwinds as geopolitical tensions in the region as well as stubbornly high exchange rate are starting to take their toll.” However with weather related distortions affecting the data and the PMIs rising strongly, there is a good chance that job growth will recover next month. Consumer spending in France also declined but confidence in the Eurozone improved slightly but unfortunately the increase in sentiment was not enough to overcome the downside surprise of the German and French data. As a result, euro continued to drift lower towards our 1.3550 pre-ECB target.

GBP Hit by Decline in U.K. Yields

Next to the New Zealand dollar, the British pound was the day’s second worst performing currency. Sterling dropped to a 6 week low versus the U.S. dollar on the back of lower gilt yields. No U.K. economic data was released today and there is nothing notable on the calendar for the next 24 hours. While the decline in U.S. yields was the big story of the day, sterling did not receive any support from the move because 10 year gilt yields fell more than 10 year Treasuries, a dynamic that is more negative for the GBP than USD. There is no question now that GBP/USD peaked at 1.70 and the continued decline in the currency indicates that investors are starting to reduce their bets on a 2014 rate hike. This week is an extremely light one for U.K. data and the decline in U.K. yields reflects an adjustment in positioning. According to last week’s CFTC report, speculators remain very long sterling and with the BoE refusing to signal plans to raise rates, some traders have started to reduce their exposure. The real test for the GBP will come next week when all of the PMI reports are released.

Not a Good Time to Buy USD/JPY

Despite the rally in U.S. stocks, the Japanese Yen traded higher against all of the major currencies today. The sell-off was led by the weakness in high beta currencies and the decline in USD/JPY. No economic data was released from Japan overnight and the Nikkei was virtually unchanged. Bank of Japan Governor Kuroda gave a speech at a conference but no comments were made on the economy and monetary policy, which only further verifies that the move in the Yen had nothing to do with Japanese fundamentals. There’s an article in Bloomberg this morning that states “Yen Gains to End as BoJ Easing Seems Unavoidable.” While we agree that the BoJ will need to increase stimulus this year and eventually U.S. rates will rise, leading to a rally in USD/JPY, buying USD/JPY and betting on a rise in U.S. rates has been the two biggest losing trades of the year. At the start of 2014, everyone was convinced that USD/JPY was headed above 105 and 10-year yields would breach 3% but half way through the year, many investors are abandoning those bets. The trades became crowded quickly and now many of those same investors have either booked or are floating losses, reducing their appetite for additional risk. These losing bets also explain why volatility has been low because managers are reluctant to revisit a trade that has not worked for the past 6 months. As Bloomberg states, eventually that will change but the question is when because right now the BoJ’s optimism and Fed’s caution is not conducive to short Yen trades. Beware of tonight’s retail trade numbers, which will tell us how demand fared after strong spending in March.